Revisiting Today's "Failed" Bund Auction: Less Than Meets The Eye

In the aftermath of today's so-called failed 10 Year Bund auction, the number of explanations seeking to goal seek some preconceived theory as to what happened has soared with justifications ranging from the amusing to the bizarre to the outright ridiculous. Here is the bottom line: "failed" Bund auctions, in which the Buba (Bundesbank or the German monetary authority) steps in to "retain" an unbid for amount and hit a maximum issuance happen all the time. In fact literally all the time as the inset chart shows. Such is the Buba charter - some European countries fail to issue the maximum amount (such as Spain and Italy in the past week), others see the central banks filling the demand. This has nothing to do with implicit or explicit monetization (because if it did then every Primary Dealer takedown in a US Treasury auction would also constitute monetization), or with some opaque negative repo prevention scheme (incidentally negative repo rate in the US bond market happen all the time - see here for instances in just the last week). It has everything to do with lack of demand at a given price. Nothing more, nothing less. And while it is intriguing to fabricate complex theories about broken secondary conduits or what have you, the explanation is far simpler. As SocGen puts it: "The fact that the Buba was forced to retain the biggest share of the sale in recent memory (see chart) is clearly a sign that some investors are no longer showing up or have started to buy considerably less, preferring other fixed income or alternative safe havens." No need to conceive an explanation where simply supply and demand will suffice. And in this case there was not enough demand at prevailing yields. And that in itself is the most ominous explanation because as SocGen concludes, "certain investors are starting to overlook the eurozone altogether". Lastly, for those who look at things only from a theoretical standpoint and forget there is an actual market, the direct implication is that Euro Country X spreads to Bunds just collapsed. And presto - with one "failed auction, European periphery, and that now includes France, Balgium and Austria, all suddenly look much better. Never waste a crisis...

Full note from SocGen:

German ‘safe haven’ status under review?

There were reports last week that investors in Asia were starting to reassess their exposure to the core eurozone debt markets after already having pulled their horns in on the periphery. Though such stories can be difficult to verify, the results of recent eurozone bond auctions clearly show that confidence has started to flag, even in German Bunds.

The EUR6bn, 10y sale drew bids of just 1.07 times the amount on offer if the Bundesbank’s part of EUR2.356bn is left out. This participation rate is among the lowest since the inception of the EUR in 1999 (see chart above). The fact that the Buba was forced to retain the biggest share of the sale in recent memory (see inset chart) is clearly a sign that some investors are no longer showing up or have started to buy considerably less, preferring other fixed income or alternative safe havens.

Auctions can be subject to technical considerations that include hedging of existing exposure or the execution of relative strategy ideas; however, the statistics that accompany this morning’s 10y Bund auction do not make for pretty reading and are a reason for concern as certain investors are starting to overlook the eurozone altogether.

The argument that yields have fallen too low does not stack up if one considers the levels of 10y gilts and USTs. The gilt/Bund spread collapsed to below 10bp today from 50bp a few weeks ago. The UST/bund spread plummeted to -16bp. EU 10y swaps spreads are down 10bp at 58bp after being down to 51bp earlier.

The political rhetoric from the EU leaders as well as uncertainty attributable to Treaty changes and dangers from rising contingent liabilities for the AAA nations have obviously been detrimental to investor confidence both in the eurozone and overseas.

Insofar as the contagion has recently spread from the periphery to the core, auctions like the one this morning could cause fear to escalate that, after France, markets are also starting to doubt the position of Germany as funding pressures continue to mount. With the EU summit only two weeks away, this should be a reminder to EU leaders and policymakers that political transition and austerity alone will not stop the cost of the sovereign debt crisis from escalating until a firewall is put into place.